MUMBAI, Feb 28 (Reuters) - The Indian rupee weakened sharply
on Thursday, retreating from a three-week high hit earlier,
after the 2013/14 budget increased spending despite keeping
fiscal deficit targets in place, while measures to attract
foreign flows were seen as limited.

The unit dropped 2.1 percent in February, marking its
biggest monthly fall since May 2012.

For the fiscal year starting in April, India proposes to
raise spending by funding it with higher revenues in a budget
aimed at reviving growth.

Although the fiscal deficit target was maintained at 4.8
percent of gross domestic product, investors had expected a
closer check on spending and were disappointed as the government
sought to increase taxes on certain individuals and companies.

Those tax proposals hit stocks, and the government also
disappointed some investors by not announcing a cut in debt
withholding tax.

"The market was expecting a lot from the finance minister.
The budget itself is not negative, but given the promises, the
market was expecting a lot more," said Hari Chandramgethen, head
of foreign exchange trading at South Indian Bank.

"I am expecting a 54.00 to 54.80 range in the near-term now.
A break of 54.80 is negative for the rupee as the 200-day moving
average and trend resistance coincide at that level. A breach of
that can push it to 55.15 or even 55.70 levels," he added.

The partially convertible rupee closed at 54.36/37
per dollar compared to its close of 53.86/87 on Wednesday. The
unit dropped as low as 54.49, its lowest since Feb. 22.

Before the budget was unveiled, the rupee had risen as high
as 53.59, its strongest since Feb. 8.

Finance Minister P. Chidambaram announced a budget that kept
total spending at 16.65 trillion rupees, above some market
estimates, while proposing a 10 percent tax surcharge on
wealthier taxpayers and for certain companies above a certain
income threshold.

Despite simplifying the investment registration process,
Chidambaram also disappointed investors by not cutting the
withholding tax on corporate and government bonds.

"The absence of a cut in withholding tax also disappointed.
Debt flows would have increased had the government cut the WHT,
which would have been positive for rupee as well," said Vikas
Babu Chittiprolu, a senior foreign exchange dealer with
state-run Andhra Bank.

In the offshore non-deliverable forwards, the
one-month contract was at 54.77 while the three-month was at
55.40.

In the currency futures market, the most-traded
near-month dollar/rupee contracts on the National Stock
Exchange, the MCX-SX and the United Stock Exchange closed at
around 54.70 with a total traded volume of $9.45 billion.
(Editing by Sunil Nair)